Simple, successful and sustainable - Ferguson plc
Every month we share 2 write-ups on companies we decided to examine as potential additions to our portfolio. Although the companies analysed may tick most of the boxes, if the margin of safety is not considered sufficient, we will not initiate a position but rather monitor the stock.
In case we decide to initiate a position at any time, we will share an Investment Thesis memo. For any additions to existing positions we will update you through our Quarterly Portfolio Updates.
1. Key Facts
Description: Ferguson Plc (“FERG”, “Ferguson”, “Company”) is a leading value added distributor in North America providing solutions and products from infrastructure, plumbing and appliances to HVAC, fire, fabrication and more. The Company as of January 2023 employs +34,500 people and serves over 1 million customers.
Key Financials: Over the period FY13 to 1H FY23, the Company depicted a revenue Compound Annual Growth Rate (“CAGR”) of 4.4% and operating income CAGR of 11.9%, reaching a Trailing Twelve Month (“TTM”) revenue of c. $30.0B and operating income of $2.9B (margin of 9.7%). Ferguson has cash and cash equivalents of $597 million compared to total debt and lease liabilities of $5.3 billion.
Price & Market Cap (as of 10th April 2023): Its market cap is $25.64 billion with a 52-week high of $149.81 and a 52-week low of $99.16, whereas it currently trades at $125.18.
Valuation: FERG trades at a TTM EV/EBITDA of 9.4 (10 Year average of 11.8) and a TTM EV/Sales of 1.0 (10 Year average of 1.0).
Note: Fiscal year 2022 (“FY22”) ended July, 31 2022.
The rest of the write-up includes the following sections:
2. Business Overview
5. Financial Analysis
6. Competitive Advantages, Opportunities and Risks
8. Concluding Remarks
2. Business Overview
Its history in brief
Ferguson Enterprises (the North America business) has a long history dating back to 1953 and was acquired by Wolseley plc in 1982 (a UK company with history dating back to 1880s). Fast forward to 2017, Wolseley plc was renamed to Ferguson plc given that most of its business was coming through its largest subsidiary in North America (Ferguson Enterprises) and in order to indicate its focus towards the North American market.
By January 2021, Wolseley UK (the last European subsidiary) was sold, completing its shift to North America. As a consequence, on May 12, 2022, the primary listing was changed from London Stock Exchange to New York Stock Exchange so as to align it with operations, management and associates. Yet, it remains a UK tax resident as the Company’s affairs are managed and controlled in UK.
The listing in NYSE creates a significant potential for the evolution of Ferguson’s share price, since an inclusion in the S&P500 would attract more institutions to invest in the Company given their investment mandates. Nonetheless, over the long term the fundamentals and the execution will prevail the short term price drivers.
Over the years, the Company grew significantly, both organically and through acquisitions, attempting to consolidate a highly fragmented market while it delivered total returns of 1481% since inception until April 11th 2023, i.e. CAGR of 8.26% (source: stratosphere.io).
FERG is a ‘value-added distributor providing expertise, solutions and products from infrastructure, plumbing and appliances to heating, ventilation and air conditioning (“HVAC”), fire, fabrication and more.’
A FERG customer can be a trade professional, a general contractor, a plumber, a builder, an architect as well as the end customer.
What is a value-added distributor?
A value-added distributor offers more than just reselling the product or ‘moving boxes’. It offers choice, innovation and experience making the life of the customer easier.
For instance, Ferguson has a large number of suppliers providing product depth to its customers while it serves its customers through various channels offering convenience. It can also provide tailored solutions like project management, virtual design, tendering, inventory management etc. minimizing project inefficiencies and ensure that products reach customers on time through its various delivery options (same day delivery, pickup by a pro, just in time, locker pic-up etc.).
To understand why efficiencies are important we will lay down few key numbers. In Autodesk and FMI 2021 report, it was stated that for 2020 the global cost of rework on construction spending was estimated at 5%, or $625B whereas in a report released in 2018 by PlanGrid and FMI, it was stated that $31.3B (out of $65B) of US cost of rework was due to poor data and communication with the remaining caused by design changes, faulty or delayed materials and more.
Value-added distributor role goes beyond the sale of a product/solution and includes after sales support like warranty, credit, returns, maintenance, repair and operations (“MRO”) support etc.
After-sales not only matter to a customer but to a supplier as well. Think of a smaller supplier who cannot bear the credit risk for a large project beyond its means when this can be easily managed by a large distributor like Ferguson. Or even think of a large supplier that will have to deal with numerous returns creating an administrative hustle when it can pass on this responsibility to a single distributor and deal with one large account only.
Ferguson’s Distribution Network
Ferguson’s ultimate purpose is to bridge the gap between its fragmented supplier (37,000) and customer base (over 1 million) and it does this with over 1,700 branches across North America. As it can be observed from the below image, the Company does not have any customer or supplier concentration risk which effectively gives it a pricing power (more on this later).
Source: Ferguson Annual report FY22, Note: Over the 1st half FY23 headcount was reduced by c. 1,500 and actions were taken in February 2023 to reduce them by further 500.
Ferguson has an extensive distribution network consisting of 11 distribution centers (10 in US, 1 in Canada), 1,720 branches (1,509 in US, 211 in Canada) and specialist sales associates, counter service, showroom consultants (with c. 250 showrooms in US) and e-commerce while it is estimated that 95% of its customers are within a 60-mile radius giving it a compelling advantage to reach customers promptly and cost efficiently.
The Omni-channel experience gives a 24/7 access and customers can buy online through ferguson.com and build.com (mainly home improvement, renovation). Both sites are important to the overall success of the Company given the changing purchasing trends of customers as online can save time and cost to the contractor, trade professional and owner. They can check availability and pricing in advance while at the same time exploring other products/ideas.
We did not identify any updates regarding the e-commerce size yet the below quotes by Kevin Murphy, CEO on FERG Virtual Investor Day (“VID”) in January 2022 demonstrate the importance of the digital channel.
“Today, overall, electronic commerce represents 21% of our total revenue. Customers actively engage with Ferguson through our app or ferguson.com.”
“Through Build with Ferguson, we've combined that showroom consultation with an industry-leading e-commerce experience for decorative home improvement. In 2007, we acquired Build.com, which at the time was a stand-alone $30 million decorative plumbing e-commerce business. By combining Build with the capabilities of Ferguson, we've grown this business to a nearly $2 billion solution for the light decorative pro and the project-minded consumer.”
Remarkable allocation skills you might think. Be patient, we will cover this later.
Another important aspect of its sales channel are the market distribution centers (“MDC”) which Kevin Murphy, CEO identified as the future due to the efficiencies they bring. Currently, there are two operating MDCs (Denver and Phoenix) and the Company is on track to build 2-3 per annum.
Why are MDCs so important? They offer branch replenishment and final mile distribution to customers while automations bring cost savings. See the below quote from Kevin Murphy, CEO during the VID 2022 (own emphasis).
“I talked about the development of our newest Denver MDC, a 450,000 square foot facility with today, almost 75% of the lines being picked utilizing robotics.
This allowed us to save 100,000 square feet with 50% less rolling equipment, creating a safer and a more efficient environment. Branch sales have accelerated more rapidly than we even anticipated, built on the breadth and depth of our product availability and the speed with which we can get it to the job in the local market.”
Please also note that per a video shown on the day it was claimed that order fulfillment time was reduced from 35 minutes to just 5 minutes.
How does Ferguson source its products?
“We source products from 30 countries, utilizing 53 global ports, shipping over 22,000 containers each year. We have over 250 sourcing professionals across those 30 countries ensuring product development and that our quality assurance and quality control process is sound.” Kevin Murphy, CEO on VID 2022 (own emphasis).
In addition, it is claimed that over 95% of the products sold in the US are sourced from US-based suppliers and over 92% of the products sold in Canada are sourced from Canada-based suppliers. That in effect, mitigates availability risk and reduces foreign exchange risk. Ferguson is not immune to global supply chain disruptions as these suppliers may source raw materials from abroad but having 37,000 suppliers spreads the risk.
The Company has two reporting segments, United States and Canada with US accounting for c. 95% of sales and +95% of segmental profits.
Source: Company filings, Stratosphere, StockOpine analysis | Note: Current/LTM growth represents the growth in the first half.
Over the period FY18 to 1H FY23, US sales depicted a CAGR of 12.7%, with Residential segment generating 13.2% CAGR and Non-Residential generating 12% CAGR, reaching total TTM sales of $28.5B.
During this period, adjusted operating margin grew from 8.4% in FY18 to 10.5% on a TTM basis, a result of continuous efficiency improvements and operating leverage gains. A key driver of the increase in margin in FY22 and beyond was inflation which also accounted for c. 20% (out of the 26%) of the FY22 US sales increase. Moderation is expected going forward but management believes that price levels are steady and thus no material decline is expected on gross margins.
“But generally speaking, the pricing levels are steady. They're supported by what we think are some structural floors that we'll keep price in a reasonable place.” Kevin Murphy, CEO
As volumes decline due to an economic slowdown, a deleveraging should be expected, yet management recently maintained its FY23 margin guidance which is a positive note for future margins (more on Outlook later).
Another support force to the gross and eventually operating margins are own brands. Own brands account for c. 8% of total sales or $2.3B (9% back in VID 2022) but in general carry a double gross margin. Management failed to keep its VID target of growing own brands at 2x times faster than Ferguson core growth but this was impacted by inflation that drove commodity prices higher. Own brands still increased by c. $400M in FY22. As of Q1 FY’23, own brands accounted for 9.5% of total sales showing signs of improvements.
Source: Company filings, Stratosphere, StockOpine analysis
As noted earlier, Residential grew slightly faster than Non-Residential segment but Ferguson maintained a balanced exposure on its end markets with 53% Residential and 47% Non-Residential. Such balanced portfolio assists in navigating challenging economic conditions. Its portfolio durability is also justified by its repair, maintenance and improvement (“RMI”) and new construction balance.
Back in FY 2008, RMI, which is considered less prone to recession pressures and thus more durable (given the necessary, non-discretionary maintenance), accounted for 31% of total US sales whereas with its intentional actions as of today, the Company shifted focus to the more resilient RMI market which accounts for 60%.
These two quotes will help you understand the different dynamics of each side of the business (own emphasis):
“Residential markets were most significantly impacted by the slowdown in new residential construction and an area serving the project-minded consumer whereas repair, maintenance and improvement markets, particularly high-end remodel showed continued strength.”
“An aging housing stock and the utilization of pros and remodel projects should support residential repair, maintenance and improvement where we have greater exposure than new residential construction.”
Overall, we are optimistic about Ferguson’s future despite a challenging short term environment. More details regarding long-term trends are addressed in the Opportunities section of the report.
Market share in North America
Ferguson reaches 9 different customer groups and as shown on the following image it is estimated to have a leading position in most of its markets.
Its top 4 customer groups in terms of US FY22 sales are Waterworks, Residential Trade, Residential Building & Remodel and Commercial/Mechanical accounting for 21% ($5.7B), 19% ($5.1B), 14% ($3.8B) and 13% ($3.5B), respectively.